Money Coach

11:26 am

Tue May 14, 2013

Why Should We Care About The Stock Market?

I'm Michel Martin and this is TELL ME MORE from NPR News. Coming up, by now, you've probably heard about so-called Tiger Moms and Dads. That term refers to Asian-American parents who allegedly keep their cubs on a tight leash and demand academic excellence. Now we're learning more about whether that parenting style really works. We'll talk about that in just a few minutes.

But first we want to talk about something you've probably heard about, even

if you don't regularly follow financial news, and that is that the Dow Jones Industrial Average has been hitting record highs over the past few weeks, and you might be asking what, if anything, does this mean for people without big fat portfolios? So we've called one of our longtime contributors, our money coach, Alvin Hall, to tell us.

Alvin, welcome back. Thanks so much for joining us.

ALVIN HALL: Glad to be back.

MARTIN: So what is the Dow Jones Industrial Average and why do we talk about it so much?

HALL: The Dow Jones Industrial Average was created back in 1896, and at the time it really contained the industrial stocks that were growing in the U.S. economy. Today it is much more diverse, consisting of 30 stocks that represent often the best in their industry. So you're looking at companies like Wal-Mart, Johnson & Johnson, McDonald's, Boeing, Coca-Cola, and these are thought to be leaders of the future of the U.S. economy.

MARTIN: So here you are, you're listening to this, and if you are in the market, as they say, and if you follow the market, then presumably this has something to do with you. But what if you aren't?

HALL: Well, most people are in the market but in ways they do not know. For example, if they have a 401K at their office or a benefit plan at their university, then they are in the stock market and they are watching their assets grow at this time. For those people who are outside of the market who don't have assets in the market, then the movement of the Dow is considered to be a leading economic indicator of what should happen in the next six to nine months.

If this prediction is fulfilled, this means that companies will begin to hire, house prices might begin to recover a bit.

MARTIN: I was going to ask you about that. How is that this incredible run in the Dow - in fact, President Obama got some criticism for talking about this during the campaign when he said, you know, the market's doing fine. And people were like, how is this possible that the market could be doing fine? There's this incredible run in the Dow, but we still see unemployment at high levels. Long term unemployment's still at high levels and economic growth just not at the level one would want to see to soak up that high unemployment.

How is it that both things could be happening at once?

HALL: There are three things that are affecting this. One is the belief among institutional investors that a great rotation is occurring from bonds into stocks, so all the money in mutual funds, retirement plans and all of these big institutional players are looking at stocks because they're looking at the yield on some of these great stocks.

This does not, however, translate to the managers of those companies. They are still being very, very cautious. They're almost like the small investor in some way. They want to see that the economy has recovered and is still doing well before they allocate any of their assets to hiring new people. That's why you see that disconnect between the Dow Jones Industrial Average, where they're putting their company's money and their investors' money, as opposed to how they're using the company's money itself.

MARTIN: Is there any concern that there is some kind of a bubble at work here, that some of these stocks are overvalued?

HALL: That is a really good question and this leads us to talk about an important theory of the market. There is the theory that says that when the small investors begin to enter the market, that the market is reaching a high. Therefore that's a contrarian indicator and the market is about to drop. That's what the theory says.

To me that is possible...

MARTIN: I was going to ask, what do you think about that?

HALL: Well, I think those theories have proven true over the years, but what I think the market's movement tells you is that timing the market is very difficult to do. The prudent investor uses asset allocation and diversification to always have some exposure to the stock market so that when it starts up, you are benefiting.

Then, if you think the rally is continuing, then you start to feather some of your money into the market very slowly and systematic. Don't jump in all at one time and say, oh, I'm going to make a lot of money because the Dow is up 15 percent. It's going to go higher. No. Feather your money into the market so that during those ups and downs you take advantage of dollar cost averaging.

MARTIN: Is there really a wealth - are we seeing any signs of a wealth effect here? We've been talking in recent weeks on this program about the continuing doldrums in housing. You know, housing prices are also recovering, but we've also been learning that a lot of that recovery is due to investors buying houses for cash, not necessarily individual...

HALL: Yes.

MARTIN: ...homeowners. And there's, of course, some debate about whether this is kind of good or not good. One point, though, that people come back to time and again is that, when people's home prices are rising, they tend to feel...

HALL: Yes.

MARTIN: ...a wealth effect. They tend to feel richer and spend...

HALL: Yes.

MARTIN: ...more. Does the same thing happen with a stock market run like this? You know, taking your point that a lot of people are in the market, even if they don't think about it a lot.

HALL: Yes.

MARTIN: But this has been going on now. This is a record high and yet you still feel people not feeling that optimistic. So do you see any sign of a wealth effect happening here?

HALL: I do, because if you look at some house sales, they seem to be creeping up more and more. The Dow is up 15 percent since the beginning of the year. Fifteen percent is a big number in many people's eyes, so all of a sudden they're saying, well, either I can put my money into the stock market or I've recovered enough to take some of those assets and deploy them elsewhere. And one of the things that people are looking at is underpriced housing and trying to use that as a way of diversifying, so I think we are seeing that wealth effect.

MARTIN: Finally, Alvin, a final question to you. We have about a minute and a half left. You're always good about giving advice to - if I can use this term - regular people about how they should play this. You know, given that a lot of people's stocks are tied up in retirement accounts and not just, you know, able to be kind of moved around, but even with that, is there any way in particular you would urge the average investor to take advantage of this opportunity?

HALL: Yes. Rather than putting more money in bonds, which is where most people had retreated, bond yields are so low and you run the risk that if interest rates start to tick up, bond prices will go down, although many fund managers have mitigated that.

Start to think about allocating a small amount of your money to the stock market. So now we've seen the market is recovering. We don't know how long that will last, but don't try to time the market. Try to take advantage of the long term trend of stocks moving upward by moving a little of your money and shifting the percentage that you allocate into stocks. Increase it so therefore you take advantage of it. That's the easiest way for all of us to take advantage of this increase.

MARTIN: Alvin Hall writes about and teaches about personal finance. He was with us from NPR studios in New York City. Great speaking with you, Alvin.